Opinion: Dear Adviser: Are U.S. stocks and bonds safer than foreign investments?

MitchTuchman

Dear Adviser:

My client noticed that his portfolio has a lot of international stock- and bond mutual funds. He asks: “Why do I need international investments at all? Don’t I get that from U.S. companies doing business abroad? Isn’t it safer and better to own stocks at home?” What compelling argument can I make to him?

I would frame your client’s question with another example that is easier to answer: Isn’t it safer and better to own the stocks of only the largest U.S. companies and avoid small U.S. companies?

Most investors and virtually all financial advisers would answer that question with a resounding “No!” While certain kinds of small-cap stocks have tended to outperform the S&P 500SPX, -1.54%
, that’s not the point at all — the point is diversification.

Owning a variety of investments lowers portfolio risk and boosts overall return. Non-U.S. stocks are a key way for U.S. investors to diversify their portfolios. Both the developing world and foreign developed-country stocks will be a major source of growth for many decades to come even as their economies go through ups and downs, just as the U.S. will.

Clients have asked us whether foreign exposure through shares of U.S. multinational companies is enough. It's not. That strategy only increases your investment concentration at home. Researchers have long documented what’s known as “home bias,” the tendency for investors to favor their own country’s financial markets.

Consider this analogy: Imagine you are loading people of different shapes and sizes into a boat. The sensible choice would be to distribute the weight carefully. Otherwise, the vessel might flip and sink.

The same is true of an investment portfolio. Foreign stocks and bonds, just like small-cap U.S. stocks, provide a counterbalance to large U.S. stocks. They keep the portfolio steady and seaworthy.

Tell your client that loading up on shares of big U.S. companies upsets the boat. Accordingly, either own a mix of securities or risk giving away the powerful gift of true investment diversification.

Do you ever find it challenging to discuss money, investing, retirement, life-planning or other sensitive issues with clients? Send your questions to “Dear Adviser” at mwfinancialadviser@marketwatch.com . Please include the state where you live. If your question becomes the subject of a column, your confidentiality will be protected, though we may contact you to confirm or clarify details .

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